VHVK E Newsletter October 2020
Oct 2020
Volume IV Issue 3
VHVK Law Bulletin
We are pleased to bring you this third issue of VHVK Law Bulletin 2020, as the recovery from the COVID 19 pandemic progresses. The current issue covers the following:
- Equal treatment of property owners in land acquisition for highways and for other purposes (Supreme Court of India)
- Intervention in appeal in the quantum of damages awarded in arbitration (Delhi High Court)
- GST not payable on remuneration to executive directors of companies (Karnataka Authority for Advance Ruling)
- Tenants’ not entitled to automatic rent waiver when premises closed used during COVID 19 lockdown (Delhi High Court)
- Significant amendments made to restrictive rules on holding farmlands in Karnataka
- Letter of comfort does not amount to a guarantee unless standards under the Indian Contract Act 1872 are met (Bombay High Court)
Supreme Court upholds equal compensation rules for land acquisition
Owners of lands acquired for building national highways are entitled to compensation and interest on par with owners of lands acquired for any other purpose. The ruling in Union of India v Tarsem Singh1 places all types of land acquisitions on par in payment of compensation and interest.
Land acquisition for building highways is made under the National Highways Act 1956. Acquisition of land for other purposes is governed by the recently-enacted Land Acquisition Act 2013, which has a more beneficial and generous compensation regime for landowners.
Construction of highways has been a priority for the Government of India and for building highways, the Government has acquired large tracts of land. Acquisitions for national highways are governed by a special legislation – the National Highways Act 1956. The Highways Act expressly excludes application of the Land Acquisition Act 2013,2 which governs acquisition of lands for other purposes and offers more generous compensation for landowners.
Exclusion of lands acquired for highway construction from the more beneficial regime under the 2013 Land Acquisition was quashed by the Supreme Court. Accepting the plea that the exclusion was arbitrary, the court ruled there was no justification to treat lands acquired for highways differently from lands acquired for any other purposes. The ruling promotes equity in compensation for landowners whose property is acquired without their consent, and for public purposes.
Delhi High Court intervenes in low award of damages in arbitration
In SMS Ltd v Konkan Railway Corporation Ltd,3 the Delhi High Court set aside an arbitral award made in a construction contract dispute. The contractor was awarded Rs. 1.73 crores damages in arbitration, against Rs. 89 crores it sought. Holding that the reduction of damages by the arbitrator was arbitrary and not supported by any recognized formula, the court set aside the award.
The contractor was required to build a 5-km tunnel in Jammu and Kashmir for the Northern Railway. The project was delayed for a number of reasons that included inadequate technical preparation by Konkan Railway Corporation (which awarded the contract), work disruptions, resistance from village communities and litigation. Considering the events, Konkan Railway Corporation extended the contract completion period by about 13 months. Taking the position that the extension offered was inadequate for the work to be done, the contractor terminated the contract. It initiated arbitration to seek compensation for the loss it claimed to have suffered in the transaction, quantified at Rs. 89 crores.
The arbitral tribunal awarded Rs. 1.73 crores, a fraction of the amount sought. The contractor challenged the award under section 34 of the Arbitration and Conciliation Act 1996. In considering the contractor’s challenge to the low amount of damages awarded, the Delhi High Court noted the arbitrator had not applied recognized methods such as the Ministry of Road Transport & Highways (MORTH) Handbook or the Hudson Formula, to compute the amount.
An important question the case raises is the scope of courts’ appellate jurisdiction under the Arbitration Act 1996 (section 34). After the amendment in 2015, the jurisdiction is considered to be more narrow. In the case at hand, the Delhi High Court adopted a broad approach and considered all aspects including the amount of damages. It remains to be seen whether the issue is carried to the Supreme Court of India and how it is decided there.
GST not payable on remuneration to executive directors
In a welcome development, the Karnataka Authority for Advance Ruling (AAR) recognized the distinctions among classes of company directors and held Goods and Services Tax (GST) does not apply to executive directors. This was in the Case of Anil Kumar Agarwal.4 The ruling corrects the earlier overlooking of the differences between executive and non-executive directors.
Most companies, in particular larger public companies, have boards with three classes of directors:
- Executive directors that are employees of the companies
- Non-executive external directors that do not work for the companies
- Independent directors, who are non-executive
In general, directors’ services are subject to GST.5 They are taxed on “reverse-charge” basis and companies receiving the services must pay the tax. Regrettably, the notification does not distinguish among the different classes of directors and treats them as generic. This overlooks that executive directors are company employees and the general rule that employees’ remuneration is not subject to GST. Karnataka Advance Ruling Authority’s decision in the case of Anil Kumar Agarwal clears the air and aligns executive directors’ remuneration with the general principle that employment relationships do not attract GST.
No automatic rent waiver during COVID lockdown, Delhi High Court rules
In the absence of force majeure (reasons beyond control) clause in lease contracts, tenants are not entitled to automatic waiver of rent for commercial premises during COVID 19 lockdown. In Ramanand v Dr Girish Soni,6 the Delhi High Court recognized that business closure during the lockdown amounts to force majeure. But the lease contract between the parties must provide for suspension of rent during force majeure conditions, for a tenant to seek rent waiver.
The case in the Delhi High Court involved a tenant that had suffered an eviction order. Conditional stay of eviction was granted, subject to the tenant paying enhanced rent. Citing the COVID 19 lockdown of business, the tenant argued for waiver of rent because of the force majeure conditions.
Examining the Indian Contract Act 1872 (section 32), the court noted the plea of force majeure would be available to parties only if it was included in the contract. In the case of the tenant, the court held force majeure had no application and the tenant was not eligible for rent waiver despite business closure during the COVID 19 shutdown.
Karnataka liberalises restrictive rules on agricultural lands
Restrictions on holding agricultural land in Karnataka have been in force since the 1970s. Through an ordinance promulgated in July 2020,7 Government of Karnataka introduced significant relaxations to the restrictions in force under the Karnataka Land Reforms Act 1961 (KLR Act). Bar on sale of farmland to non-agriculturists is lifted and ceilings on farmland holdings are increased.
The far-reaching changes introduced by the Ordinance are summarized below.
- Prohibition on sale of farmlands to non-agriculturists is repealed (KLR Act section 80)
- Ceilings on agricultural land holdings are doubled. The new limits are 20 acres of “Class-A” land (with access to irrigation facilities) per family of 5, with 4 units more for every additional family member (amendment to KLR Act section 53). The ceiling is higher for other classes of land that lack irrigation facilities. The ceilings for other classes of land are specified in Schedule 1 to the KLR Act.
- Prohibition on non-agriculturists holding farmland is abolished retrospectively from 1974 (KLR sections 79A, 79B and 79C repealed with retrospective effect)0
- Restrictions on mortgage of agricultural lands to recognized financial institutions, cooperative societies and public sector entities continues (amendment to KLR Act section 81)
- The amendments do not validate farmland transfers made by members of scheduled castes and scheduled tribes, protected under the Karnataka Scheduled Castes and Scheduled Tribes (Prohibition of Transfer of Certain Lands) Act 1978. Transfers made in violation of the statute continue to be invalid (KLR Act new section 80A inserted).
Arguably, the changes introduced by the Ordinance are radical. Introduced during the COVID 19 lockdown through an ordinance (without discussion in the Legislative Assembly), the changes validate farmland holdings by non-agriculturists contrary to the prohibition that has been in force since 1974. Farmlands and the agricultural sector are sensitive subjects and the political reaction to the changes remains to be seen.
Bombay High Court sets standards for letter of comfort to be treated as guarantee
A “letter of comfort” issued by a corporate parent to the lender in a borrowing by a subsidiary would not become a guarantee unless it fulfills the applicable conditions under the Indian Contract Act 1872 (section 126). This was the ruling of the Bombay High Court in Yes Bank v Zee Entertainment.8
Parent companies supporting subsidiaries with letters of comfort is a common practice in corporate groups. In the Zee Entertainment group, the leading media and entertainment group, Yes Bank provided a loan to a Zee subsidiary to fund a series of intercorporate financial arrangements within the group. Yes Bank lent US$ 50 million to Living Entertainment Enterprises Pvt Ltd (LEL) and the plan was this would be repaid through sale of shares in another subsidiary (Veria International Ltd) under a put option to a third subsidiary of Zee (ATL Media Ltd). For the Yes Bank loan, the parent Zee Entertainment Ltd issued a letter of comfort that stated it will
support [ATL] by infusing equity/debt for meeting all its working capital requirements, debt requirements, business expansion plans, honouring put options, take or pay agreements and guarantees
Faced with default from the borrower (LEL), Yes Bank brought legal action. It contended the letter of comfort issued by Zee Entertainment amounted to a guarantee and as such, Zee Entertainment was liable to repay the loan taken by its subsidiary, LEL. Zee Entertainment denied the letter of comfort amounted to a guarantee in favour of Yes Bank.
The Indian Contract Act defines a guarantee as a “contract to perform the promise, or discharge the liability, of a third person in case of his default” (section 126). Applying the statutory standard, the Bombay High Court held that the letter of comfort did not qualify as a guarantee. The case underscores the importance of right wording in letters of comfort issued to lenders for third parties’ liabilities, including subsidiaries and affiliates in corporate groups.
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VHVK Law Bulletin is issued for information purposes only and does not constitute legal advice. For more information on any of the material covered here and/or their implications for your situation, please obtain competent legal advice.